Startups Lose in a Low-Rate World, and the Fed Is Blaming Itself
bloomberg.com
bloomberg.com
This would normally create inflation but because investors are aware of this, they don't want to keep their wealth in cash during times of low interest rates, so they invest in index funds instead... Index funds are historically the safest store of value which can consistently beat inflation. The most popular index funds only invest in the top, biggest corporations.
So basically most of the newly created money flows straight to big corporate shareholders and executives via share price increase (note that the majority of that value is not cashed out for spending on consumables; it stays within the corporate sphere as investments). The inflation only occurs in the corporate sphere and so it doesn't impact consumer prices (therefore inflation appears to be normal from the consumer perspective). All corporate activities become more expensive though; processes become slower, employees become less productive, advertising becomes more important and expensive. Wealthy corporate insiders lose their relative sense of value because they get used to seeing higher operational costs and lower Price to Earnings ratios.
If all corporations have more cash and have nothing to do with it, they will just spend it on marketing... Otherwise they risk losing brand awareness. In a low rate environment, brand awareness is more valuable than cash because it has future value that will be carried through beyond the current economic environment... To a time when cash will have more value.
I think that the later points you make about inefficiencies are great, and especially apt/worrying in the large cap tech world.
FB & Twitter are a prime example. They increased headcount and costs by 10X-100X, after becoming massive platforms scaled to serve everyone in the world. The product twitter and Facebook serve is still the same product they served with a 10th of the employees.
Sure, the ad-tech grew, but that cannot plausibly obsorb thousands of engineers. What mostly grew is various forms of administration.
If Toyota got swallowed by the earth tomorrow, the world's ability to produce cars takes a real hit. Real investment will have to be made to replace this capacity. If Facebook or Twitter disappeared, a handful of resourceful people would have a clone up in days.
That's a frightening level of inefficiency.
I think you're vastly underestimating the complexity of running a product like Facebook or Twitter. At scale, every minor problem gets magnified in both product-terms, and raw technical-terms. This requires investment of people and resources.
As a simple example, consider that Facebook has to build, and evolve its own php-esque language runtime. This has properties tuned to the specific traffic patterns of Facebook, thereby saving many millions of dollars in server costs.
So, no, I vehemently disagree that a handful of resourceful people can clone Facebook, beyond the most obvious high-level features that you may be familiar with from your personal usage. Similar arguments will apply to Twitter.
I think you're vastly underestimating how much scale they already had, before all these people. When FB IPOed (just 6 years ago) FB were operatating with 1/10 the current resources. ATT, they were already generating revenue and private investors were falling overthemselves to invest.. so it's not like times were leane then.
Since, revenue, expenses & headcount has grown 10X. FB is still basically FB. If their ad business had capped off at $8bn instead of $80bn, my guess is that almost nothing a user notices would be different. It's not proveable. You can always counter that FB does 10X more than they did 6 years ago. We can't count the number of cars leaving a factory.
You still need to hire a team, implement the hardware, understand the nuances, and also build up datasets of trade history, etc. What once in theory sounds easy, might not be as simple as you think.
Facebook and Twitter have the users, old content and built social networks. They have data on user patterns, relationships with advertisers, etc. I don’t think it would be as simple as you think.
If you model a person as a decision engine, assigning a fixed number of decisions able to be made at a time, then investment leads to increasingly large amounts of capital decisions being delegated to fewer and fewer people realistically.
Shareholder value optimi and minimization of liabilities through wage growth suppression over time create a divergent flow of cash away from agents willing capable of making decisions counter to the primary objectives of entrenched actors.
You not being in a financial position to invest in a community operated grocer is a consequence of long term winner-takes-all market trends. The decision was made elsewhere and only percolate down to you after a long chain of financial transactions eventually terminating at your employer.
It's a fascinating mental model I've been toying with, and trying to figure out what data I'd need access to to prove or disprove any merit to the supposition.
That's bad for innovation overall and our economy in the long term. It's probably the best time to be a founder looking for a quick exit though. Easy funding and lots of buyers willing to pay a lot.
Aren’t these two points contradictory? When acquisition opportunities are plentiful, people are more likely to start/invest in companies, leading to more innovation and development, no?
Let’s say the govt rate is 6% and the risk is 6%. If you’re discounting cash flows from 10 years out (when the company is full sized) then every future dollar is 1/(1.12^10) dollars today. If the riskfree rate is 2% then that future dollar is worth 1/(1.08^10) - a lot more! Since startups have no cash flows today, their value is all a risk adjusted bet in future cash.
Another intuition is when you need funds, it’s best to get them when money is cheap. (The lower the interest rate, the less you have to pay later for money today)
Note - this isn’t precise, and there are exceptions, but generally I’ve thought that startups do well with low rates.
In this low-rate environment, the established business can take on 2x the leverage of the startup while paying the same interest, but in the high-rate environment only 1.5x.
Low rates encourage all firms to use credit, but the countervailing competitiveness of large/stable firms diminishes the ability of startups to take advantage of it. This is all speculative on my part.
If the choice was between a startup and an experienced junk-rated company - I guess for those risk averse investors in this low-yield environment - the latter would be a wiser investment. One can achieve a much faster profit if the firm borrows for share buybacks, dividend recaps, etc.
But in theory, this is good for startups. While lower-rates are crowded out, there are much more willing buyers (other companies) for the startups - more supply, limited demand, higher price: higher valuation.
Extraordinary claims require extraordinary evidence but the article provides none, and the study's the article links to are behind a paywall.
I'd go a step further and say the vast majority of startups borrow money from traditional banks, through home equity, business loans or credit cards.
The startup world is far larger than the stuff we read about on Demo Day.
If you watch the videos on Sweetbridge, reducing the WACC for startups and small businesses is one of the main promises of DLT.
What constitutes a "fair rate", though?
Despite popular opinion, banks are pretty damn good at assessing risk. The fact of the matter is, most small business fails. The rates reflect that.
Sweetbridge looks interesting, but the risk falls somewhere, even if more diffuse.
OK but if you look at only the small businesses that are going to go on to succeed and be around for the next couple hundred years, they still can't borrow at the same rates as Apple or whatever.
This is obviously correct. But it contradicts the idea that banks are good at assessing risk, if the closest that banks can come is lumping 100% of startups into a 'startup' bucket.
If banks really were good at assessing risk then the fact that the large tech companies have access to cheap capital wouldn't necessarily hurt startups, but that isn't actually the case.
I've personally experienced this recently trying to borrow money to acquire an asset: banks will throw money at you hand over fist, at amazingly cheap rates, if you structure things so that it's very very unlikely they will lose their money.
If you set up a company tomorrow with no assets, no cashflow, no nothing. Just an idea. And you go ask for a $100,000 loan. Why should a bank give you a loan, given most businesses fail?
It's 10 to 100x more risky to give a loan to a startup like that, than it is to give a loan to a profitable business that has existing cashflow and profits. Even if the interest rate is 20% for the startup and 3% for the established company.
But specifically how does that relate to start-ups and hurting growth?
Are you saying that if a big company can borrow at 'fed rate' + 2% and a small company can only borrow at 'fed rate' + 6% that as the fed rate gets smaller the relative differences in the borrowing rates increases so 8% vs 12% isn't as big of an advantage as 3% vs 7%?
Of course, large businesses can generally borrow at lower rates, but that's the way "risk" works.
Either way, as far as I understand they are independent variables to the absolute value of federal fund rate -- what matters more is the stage in the business cycle.
Technology startups that take any type of outside funding were never intended to go public and be an independent company. If the founders had any hope of that, they are blind.
Look no further than YC. Only one company that it has funded has gone public - Dropbox and it isn’t looking to good financially.